“Finance is never, ever, a theoretical exercise; you’re never half as detached from portfolio losses as you think you will be.” – William Bernstein
William Bernstein is a legend in the long term investing advice universe. Bernstein is actually a neurologist that decided to teach himself about investing and wealth management. His self-teaching eventually led him to share what he learned with other investors through a series of books. He has the quality that all great teachers of the financial markets share – the ability to take complex topics and make them easy to understand and apply to your own situation.
The Intelligent Asset Allocator was one of the first investing books I ever read that was able to coherently combine cold, hard data with common sense applications of the stated material. This book also does a service to investors by highlighting the importance that asset allocation has on portfolio performance.
Recently I’ve been reading Bernstein’s Investing for Adults series which are offered as Kindle books.
All three are relatively short (around 50 pages or so) and each deals with important topics that cover the wide spectrum of investors from those that are just starting out to those that are in or approaching their retirement years. I was planning on doing a single post to cover the lessons learned from all three of these books, but they’re all so packed full of solid investment and retirement advice that I’m going to break them up and do an individual post for each book.
First up is The Ages of the Investor: A Critical Look at Life-cycle Investing.
“It’s virtually impossible for young workers to deploy their investment capital too aggressively, because their human capital overwhelms it.” Many young investors starting out right now are still wary of investing in stocks. In fact, a survey by the Investment Company Institute found that only 26% of households under the age of 35 said they were willing to take on substantial investment risk.
Much of this has to do with the ripple effects from the 2008 crash when many saw their parents, friends or co-workers lose so much money in the stock market.
The scars still linger, but the combination of a long time horizon until the money needs to be spent and the fact that young investors have substantial future earnings they are able to invest means that the risks are actually higher for those that don’t invest aggressively.
“Higher volatility leads to more opportunities to buy at much lower prices.” Keeping with the same theme for younger investors, increased volatility early in your career should be welcomed. When you are saving money on a periodic basis it works in your favor to see market volatility and losses.
You can buy more shares at lower prices during volatile markets. Bernstein makes the point a number of times in this book that you should in fact hope for lower returns during your accumulation phase so you are able to buy more stocks at discounted levels.
Building up your investments through savings during down markets is how you make money over time. It sounds simple, but this is counterintuitive when you see the balance of your current investments decline and get that sick feeling in the pit of your stomach when you lose money.
Like a firefighter, you should run into the burning building that is down markets when you have a long time horizon.
“At no point in the history of the U.S. stock market has its real dividend stream fallen by more than half, even during the Great Depression. During the most recent financial crisis, for example, although stock prices fell by more than 50%, dividends also dropped, but by only 23% from their peak, and only temporarily.” This is important to note since dividends play such a large role in the total returns on stocks. It’s easy to get caught up in fast growing stock prices, but steady income can act as stabilizer to your portfolio during the dark days of inevitable losses.
“If at any point, a bull market pushes your portfolio over the LMP (liability matching portfolio) “magic number” of 20 to 25 times your annual cash-flow needs beyond Social Security and pensions, you’ve won the investing game.” This is an important point about your ability and need to take risk. Once you build up enough savings (Bernstein defines that number at 20-25x) to cover your living expenses and plans for the future, there’s no reason to take increased risk in your portfolio.
You don’t necessarily have to shun risk assets altogether (although you could), but you also don’t need to take nearly as much risk in your 60s as you did in your 20s.
The in-between age group is where risk tolerance can get a little tricky. Bernstein covers this in the book, but there’s no easy answer. It really depends on how prepared you are (your savings), your time horizon (when you plan to retire) and what your estimated future cash flow needs are.
“That most people do not save likely offers higher returns to those who invest liberally and aggressively when young, accumulate adequate assets for a safe retirement, then convert those assets to a safe stream of income against the day when their earning power is gone.” The fact that most people don’t save enough for financial independence gives those that do a leg up in the race too early or fully funded retirement status.
Patient capital deployed over time in financial markets is your highest probability bet at building wealth. Step one is to save enough.
How much you save is the single most important factor in building wealth.
Age of the Investor